27 July 2014

Nifty Valuation - Over valued or Under valued?

Before starting off, this article is just an update of an article we had posted last year. Read: Nifty: Over Valued or Under Valued? dated 28th November, 2013. The Nifty index was then trading 17.9

The current chart of the Nifty P/E:
Nifty P/E Ratio
Currently, Nifty trades at a P/E of 20.79 (As on 25th July, 2014). Historically, on many occasions Nifty has reached higher valuations of 23-26-28. As the above chart shows, Nifty once it starts trading above P/E of 20, it doesn't breach the 20 mark easily and does touch valuations of 22-23.5. Please remember that P/E is dependent on Earnings per share (EPS) of the Nifty and a market with rising EPS can rally without a rise in EPS, a case which we saw in the 2004-2007 period. The current EPS of the Nifty is around 374. If we assume that in this rally too like the previous ones, Nifty might go to 22-23.5, we get a minimum target of 8230 levels. So Nifty might see the range of 8230-8700 in the coming months. As EPS increases, the targets also increase. As per historical trends, we are of the view that 7480 is a mark which won't be easily breached unless there is a fall in EPS. 7480 is the levels where P/E of Nifty is 20. Fundamental analysis and technical analysis must not be confused with each other. We are analysing the index fundamentally for it's valuation. Above 20, it shows that the participants are heavily bullish and are discounting a good rise in index EPS. Currently, FII's are buying very heavily and there is a positive sentiment that the with a strong, single party government in the center, policies will be fast and beneficial for the corporate sector.

Going Forward:
The major LONG term support for Nifty is at 6700. In the current scenario, infact we don't expect the Nifty to slip below 7000. For medium term trend 7480 zone is a strong support. Any dip to this level will be used for buying. Nifty will predictably create a range of 7400-8250. We might see the index moving in this range for quite sometime. Since our earlier post on 28th November, 2013, the EPS of the Nifty has gone up from around 337 levels to 374 levels. The EPS, if compare on a year on year basis has increased by close to 11% from 334 to 374 (July '13 vs July '14). By trading at P/E of 20-21; the market is expecting the EPS to grow atleast 15% from now annually. Historically; the average EPS of the Nifty has been around 18. Whenever Nifty goes above 19, the market is discounting a fast EPS growth. With the current sentiment, the expectation can go higher and we can expect a P/E of 22.

Stocks to BUY:
In a scenario with Nifty at a P/E of 20-21, the opportunities are tough as almost all stocks are fairly valued with whatever news is available. But going for stocks with healthy margins, 20% CAGR for 5 years and trading at a P/E of 10-14 can give strong returns.

Usually, above a P/E of 20, the market is very bullish in sentiments, above a P/E of 22, it starts getting irrational and expectations of growth are of nearly 20% annually, any miss results in sharp cracks in the index till it reaches back a level of fair valuation. If Nifty where to touch a P/E of 24 now, the index could be hovering around 9000. It is not advisable to short any rise in P/E above 22 as the market can stay irrational for more time than a trader staying liquid. And if the EPS keeps increasing at the desired growth rate, the P/E might stay at 20. P/E shouldn't be looked as a technical indicator but to gauge the market expectations, sentiments and if the same is gauged with rationality, it can be used for developing a trajectory of the market and identifying profitable sectors and stocks.

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